In order to quickly gain insight into the level of tax risks for all tax types (calculation of the potential assessment), the single audit method of tax authorities can be used. This method provides a quick insight into the performance of the Tax Control Framework since the results can be used to evaluate whether or not these are within the risk tolerance limits of the company.

An overview of this method is presented below.

The term ‘Single Audit’ originates from the government accountancy. Initially, it referred to an audit simultaneously carried out for multiple supervisors/regulators and for whom the controlled has an accountability to report to each of the supervisors/ regulators.

Because of such a single audit much unnecessary duplication of work can be avoided. After all, separately monitoring different type of reports that all originates from the same (financial) accounting system, leads to extensive audit burden. A single audit reduces this burden.

For the purpose of the Horizontal Monitoring, the Dutch Tax Authority also uses the term ‘Single Audit’. This encompasses simultaneous monitoring of all relevant different tax types, such as:

Corporate Income Tax

Value Added Tax

Wage tax

Excise and Customs duties

Etcetera

The Tax Authority previously used the term ‘integrated control’ for the same concept. Although the Tax Authority is only a single party, the single audit can still, as with other single audits, limit the audit burden.

In order to ensure sufficient depth, each ‘single audit’ must be performed by specialists. The various fiscal (financial) statements all require control and therefore the use of different tax expertise is essential. Most of these ‘single audits’ will have to be monitored by a multidisciplinary team and in addition to audit expertise, knowledge on different types of tax must incorporated.

What makes the fiscal ‘single audit’ special is that the accuracy with which the Tax Authority assesses the collection of tax returns of a taxpayer is a priori expressed in terms of tax money. That is, the financial statements to be assessed are often expressed in monetary units of the base amounts of the different taxes.

A few examples:

Corporate Income Tax – the General Ledger, and thus the CIT return, only includes revenues, expenditures and balance sheet accounts but lacks the applicable CIT tax rate

Value Added Tax – the expenditure (investments/costs) will be posted in the General Ledger net of applicable to input tax and the VAT wis posted on a separate VAT balance sheet account

Wage tax: the payroll posting in the General Ledger is based gross amounts while tax audit samples are generally based on the net amount of wages

A ‘single audit’ does not imply that the (monetary units of the) defined transactions must be seen as one indivisible population. The indivisibility can however be assumed in the case of sample drawing in which risk analysis is not taken into account.

In practice this means that the following steps should be taken:

Defining the scope of the single audit

Defining the required data from the systems

Defining the sample size based on the parameters of the Tax Authority

Drawing the non-reduced sample

Determining the degree of sample size reduction based on the performed risk analysis per type of tax. Although the Tax Authority makes use of standard tables, this reduction is highly subjective.

Drawing the reduced sample. This concerns drawing a sample from the non-reduced sample (step 4)

Evaluating the sample; in case a reduced sample is used, the items that are not reviewed are assumed to be without errors.

Evaluating the results of the sample

It should be evident that certain subpopulations are created as a result of more complex interpretation and are therefore prone to a higher error probability. Other subpopulations have a lowered risk profile (e.g. due to regular, adequate internal monitoring). This needs to be taken into account with respect to the amount of work dedicated and if possible, the sample could be reduced in size.

It is obviously always allowed to use a non-reduced sample (skip step 5 and 6) when performing an internal sample check into the effectiveness of one’s own Tax Control Framework.

In the event that the Tax Authority has performed a tax audit based on the single audit method and has imposed substantial tax assessments, it is not only important to check whether the position of the Tax Authority is tenable, but also to evaluate the process. That is, it must be determined whether this process can withstand scientific scrutiny.

In the following paragraphs the methodology of reducing the sample will be outlined. The figure below depicts the population for which from every subpopulation a proportional sample of money is drawn. The starting point is that the tolerable rate in money for each of the subpopulations is equal to that of the entire population. A subpopulation of the total collection of expenditure as such could for instance be net wages, or expenditure for which the input tax on VAT returns is deducted. Furthermore, one can choose for example every class of transactions that have similar risks.

The dotted lined rectangle depicts the possibility that – due to whatever reason – not all transactions are included in the to be evaluated overall population. The figure above displays the situation in which the risk is equal across all subpopulations.

The figure below depicts different sample sizes per subpopulation. This results from a different amount of ‘prior information’ for each subpopulation.

Consumption taxes

Consumption taxes include, on one hand general taxes on consumption, typically value added taxes (VAT and its equivalent in several jurisdictions the goods and services tax sales– GST) and retail sales taxes and on the other hand taxes on specific goods and services, consisting primarily of excise taxes, customs duties and certain special taxes.

Looking at the unweighted average of revenue from the five broad categories of taxes as a percentage of overall taxation in the OECD member countries, it can be seen that the proportion of consumption taxes is almost 31% (see Table 1.1).

In 2009, consumption taxes broke down to one-third for taxes on specific goods and services and two-thirds for general consumption taxes (see Tables 3.2, 3.4 and 3.7).

General consumption taxes

Retail sales taxes

A retail sales tax is a consumption tax charged only once at the last point of sale for products to the final end user.

The United States is the only OECD country within which a retail sales tax is employed as the principal consumption tax. However, the retail sales tax in the United States is not a federal tax.

Rather, it is a tax imposed at the state level. Currently, 46 of the 50 States impose retail sales taxes. In addition, over 7 500 local tax jurisdictions impose retail sales taxes in accordance with state law requirements.

To address inter-state and international taxation issues caused by the lack of harmonisation in state sales and use taxes, a number of states have entered into the Streamlined Sales and Use Tax Agreement (SSUTA available at http://www.streamlinedsalestax.org).

Value added tax

VAT is the most widespread general consumption tax in the world having been implemented by over 150 countries and in 33 of the 34 OECD member countries.

The value added tax system is based on tax collection in a staged process, with successive businesses entitled to deduct input tax on purchases and account for output tax on sales in such a way that the tax finally collected by tax authorities equals the VAT paid by the final consumer to the last vendor.

These characteristics ensure the neutrality of the tax, whatever the nature of the product, the structure of the distribution chain and the technical means used for its delivery.

When the destination principle, which is the international norm, is applied,

it allows the tax to retain its neutrality in cross-border trade. According to this principle, exports are exempt with refund of input taxes (“tax free”) and imports are taxed on the same basis and at the same rates as local production.

VAT is a neutral tax.

The concept of tax neutrality in VAT has a number of dimensions, including the absence of discrimination in a tax environment that is unbiased and impartial and the elimination of undue tax burdens and disproportionate or inappropriate compliance costs for businesses.

Neutrality is one of the principles that help to ensure the collection of the right amount of revenue by governments in the right jurisdiction.

In domestic trade, tax neutrality is achieved by the staged payment system: each (fully taxable) business pays VAT to its providers on its inputs and receives VAT from its customers on its outputs.

Input VAT incurred by each business is offset against output VAT so that the “right” amount of tax to be remitted to tax authorities by each business is the net amount or balance of those two. As a result of the staged payment system, VAT normally “flows through the business” to tax the supplies to the final consumer.

This ensures that the tax ultimately collected along a particular supply chain is proportional to the amount paid by the final consumer, whatever the nature of the supply, the structure of the distribution chain, the number of transactions or economic operators involved and the technical means used.

VAT is a consumption tax.

From an economic standpoint, VAT is a tax on final consumption by households.

Practically, the tax deduction mechanism ensures that the VAT paid by businesses along the value chain does not bear on them but, ultimately, on final consumers only.

Therefore, only people consume while businesses rather use inputs.

From a legal and practical standpoint, VAT is essentially a transaction tax, which aims at taxing the sale to the final consumer through a staged payment process across the supply chain.

VAT in cross-border trade.

The overarching purpose of the VAT as a levy on final household consumption coupled with its central design feature of a staged collection process lays the foundation for the core VAT principles bearing on international trade.

The application of the destination principle in VAT achieves neutrality in international trade.

Under the destination principle, exports are exempt with refund of input taxes (that is, free of VAT) and imports are taxed on the same basis and at the same rates as domestic supplies.

Accordingly, the total tax paid in relation to a supply is determined by the rules applicable in the jurisdiction of its consumption and therefore all revenue accrues to the jurisdiction where the supply to the final consumer occurs.

The application of the destination principle is more consistent with the main VAT principles and is accepted as the international norm.

Although most of the rules currently in force are consistent with the destination principle, their features are diverse across countries.

This can, in some instances, lead to double taxation or unintended non-taxation and create uncertainties for both business and tax administrations.

Implementation of the destination principle with respect to international trade in goods is relatively straightforward in theory and generally effective in practice, due in large part to the existence of border controls or fiscal frontiers.

Implementing the destination principle with respect to international trade in services and intangibles is more difficult.

Their nature is such that there are no customs controls that can confirm their exportation and their consequent right to be free of VAT or impose the VAT at importation.

Since it is not possible to physically follow the flow of services and intangibles across borders for tax purposes, the connection of the supply with a specific taxing jurisdiction must be done by reference to proxies.

The nature of those proxies and the way they are used may vary across jurisdictions as a result of local history and legal frameworks.

Consumption taxes on specific goods and services: Excise taxes

Excise taxes differ from VAT since they are levied on a limited range of products; are not normally liable to tax until the goods enter free circulation and are generally assessed by reference to the weight, volume, strength or quantity of the product, combined in some cases, with ad valorem taxes.

As with VAT, excise taxes aim to be neutral internationally since they are normally collected once, in the country of final consumption.

Chapter 2 – Consumption tax topics

Taxing international trade

The spread of VAT has been the most important development in taxation over the last half century. It now covers more than 150 countries and is recognised as the most efficient consumption tax both in terms of revenue for governments and neutrality towards international trade.

The challenges raised by globalisation have led governments to undertake common action to ensure a smooth interaction between VAT systems in the context of a global economy.

Governments began the process of establishing common guidelines for international VAT issues in 1998 at the OECD Ottawa Conference on electronic commerce, where Ministers welcomed the Ottawa Taxation Framework Conditions.

As a result, the OECD’s Committee on Fiscal Affairs (CFA) adopted the Guidelines on Consumption Taxation of Cross- Border Services and Intangible Property in the Context of E-commerce in 2001.

Further to the development of globalisation and cross-border trade, it became clear that many of the problems surrounding the application of VAT to e-commerce actually had their roots in the wider area of services and intangibles and that the remaining differences of approaches amongst jurisdictions still had potential for double taxation and unintended non-taxation.

The OECD therefore launched the OECD International VAT/GST Guidelines (the Guidelines) in 2006, which aim at providing guidance for governments on applying VAT more generally to cross-border trade.

It was agreed that the most pressing issue was the definition of the place of taxation for cross-border trade in services and intangibles and the conditions for the neutrality of the tax.

It was also agreed that the right to deduct input tax, an essential element in VAT systems that underpins the tax’s neutral character, should also be assured for cross-border trade. In January 2006, the CFA approved the two following basic rules:

The burden of value added taxes themselves should not lie on taxable businesses except where explicitly provided for in legislation;

for consumption tax purposes internationally traded services and intangibles should be taxed according to the rules of the jurisdiction of consumption.

These rules reflect the overarching purpose of a VAT to impose a broad-based tax on household consumption. According to the destination principle (see Chapter 1) the revenue of the tax should ultimately accrue to the jurisdiction where final consumption occurs.

In order to progress the work, the Guidelines are being developed in a staged process with a consultation process.

The objective is to arrive at a complete set of Guidelines applying to cross-border trade in services and intangibles by 2014.

Additional work is undertaken on improving the efficiency of the tax, the fight against VAT fraud and tax administration issues.

Cross-border VAT neutrality

In principle, the right to recover input VAT for businesses is exercised through the deduction mechanism in the staged payment process.

In a cross-border context, the export of goods and services is in principle free of VAT under the destination principle.

However, there will inevitably remain situations where businesses may incur a foreign VAT.

OECD countries have often implemented special mechanisms to avoid VAT being charged to the foreign taxpayer or to allow the foreign taxpayer to recover the input VAT incurred in the country.

The conditions and procedures for relief or recovery vary considerably between countries.

The lack of consistency in these procedures across countries and their current complexity may lead to significant compliance and administrative burdens for businesses and tax administrations.

The importance of the issue was confirmed by an OECD survey issued in 2010 “VAT/GST Relief for Foreign Businesses: The State of Play” (www.oecd.org/ctp/ct).

The CFA considered that the issue was significant enough to require remedies and undertook development of guidelines in this area.

As a result, the CFA approved International VAT Neutrality Guidelines in July 2011, after a successful public consultation. These Guidelines are one of the building blocks of the OECD International VAT/GST Guidelines.

The Commentary on the application of the International VAT Neutrality Guidelines in practice was approved for public consultation by the CFA in July 2012 and was published on the OECD website (www.oecd.org/ctp/ct) for public consultation (until 26 September 2012).

Definition of the place of taxation

According to the destination principle, the taxing rights on cross-border supplies of services and intangibles should accrue to the jurisdiction of consumption.

Although VAT primarily taxes household consumption, the multi-staged nature of the tax requires that each supply within the supply chain is subject to the rules of the relevant jurisdiction, including the intermediary supplies between businesses.

Thus, appropriate place of taxation rules should be applied at each stage of the supply chain. Over the last decade, OECD countries have amended their tax legislation to implement the destination principle.

However, there is a recognised need for a consistent set of approaches that maintain tax neutrality for business-to-business supplies and ensure the application of the destination principle for business-to-consumer supplies.

As part of the work on the OECD International VAT/GST Guidelines, a number of papers were issued for public consultation (www.oecd.org/ctp/ct).

The overall work on the Guidelines should be completed by end 2014. In addition anti-abuse provisions and mutual co-operation and dispute resolution procedures should also be developed.

Improving VAT efficiency

The current economic crisis has acted as a catalyst for structural reform in many OECD countries.

In the tax area such reforms aim at ensuring the long-term sustainability of public finances while safeguarding the competitiveness of the economy and its longer- term growth potential.

The pace and nature of reforms have varied markedly between countries but a consensus has emerged on the fact that growth-friendly tax reforms could help strengthen the jobs content of a recovery”.

This includes removing tax expenditures and shifting the tax burden towards tax bases that are less harmful to employment and growth, such as consumption taxes.

Against this background, the OECD organises its first Global Forum on VAT in Paris in November 2012 as a unique international platform for a truly global dialogue on VAT design and operation, for sharing policy analysis and experience, for identifying best practices and for strengthening international co-operation.

Tackling VAT fraud

There has been a significant and worrying trend in recent years for VAT to become a target for serious criminal activity.

Despite the measures taken by tax administrations and increased co-operation within the EU, criminal attacks against VAT systems have continued, spreading into new markets such as carbon emission allowances and energy supplies.

The development of appropriate legislation and practical tools are therefore critical to protect governments against international VAT fraud.

Chapter 3 – Value added tax: Yield, rates and structure

Limited to less than 10 countries in the late 1960s, VAT is today an essential source of revenue in more than 150 countries.

A number of factors have contributed to these developments i.e. globalisation, the systemic neutrality of the tax towards international trade and its efficiency for raising revenue.

It now accounts for approximately one fifth of the tax revenues of OECD governments and worldwide.

Key features of the VAT systems

Although most VAT systems build on the same core VAT principles, many differences exist in the way they are implemented in practice.

This is illustrated by the existence of a wide range of lower rates, exemptions and special arrangements that are frequently designed for non-tax policy objectives.

The rates of VAT

After a period of relative stability between 1996 and 2008, the average standard rate of VAT has started to rise again since 2008, suggesting that many countries have increased their VAT rates to consolidate their budgets.

With the exceptions of Chile and Japan, all OECD countries have one or more reduced rate generally applied to basic essentials such as medical and hospital care, food and water supplies and to activities that are considered socially desirable.

One of the reasons for the introduction of a differentiated rates structure is the promotion of tax equity or to stimulate consumption of “merit goods” (e.g. cultural products and education) and goods with positive externalities (e.g. energy-saving appliances).

The reasons for these reduced rates are likely to be rooted in a country’s socio-economic history, but their validity and their capacity to meet their objectives at an appropriate cost may be questionable.

Exemptions

In addition to reduced rates, there is also an extensive use of exemption across countries (see Table 3.11). Although it is a significant departure from the basic logic of VAT, all OECD countries (with the exceptions of New Zealand and Turkey) exempt a number of specific sectors considered as essential for social reasons, in particular health, education and charities.

In addition most countries also use exemptions for practical reasons (e.g. financial and insurance services, due to the difficulties in assessing the tax base) or for historical reasons (postal services, letting of immovable property, supply of land and buildings).

The exemption of items used as inputs into production removes the key feature of VAT, that of neutrality.

Exemption may introduce a cascading effect as the non-deductible tax on inputs is embedded in the subsequent selling price and is not recoverable by taxpayers further down the supply chain.

The importance of this cascading effect depends on where in the supply chain exemption occurs. If the exemption occurs immediately prior to the final sale, there is no cascading effect and the consequence is simply a loss of revenue since the value added at the final stage escapes tax.

On the other hand, if it takes place within the supply chain the distortions may be significant. For example, the exemption of financial services creates significant distortions with respect to both consumer and business decisions.

Thresholds

There is no consensus amongst OECD countries on the need for, or the level of, thresholds.

The main reasons for excluding “small” businesses are that the costs for the tax administration are disproportionate to the VAT revenues from their activity and, similarly, VAT compliance costs would be disproportionate for many small businesses.

The level of the threshold is often the result of a trade-off between minimising compliance and administration costs and the need to avoid jeopardising VAT revenue or distorting competition.

Restrictions to the right to deduct VAT on specific inputs

According to the VAT principles, the right to deduct input taxes should be limited to the extent that those inputs are used for the taxable purposes of businesses.

The right of deduction is legitimately denied where inputs are used to make onward transactions that fall outside the scope of the tax such as exempt transactions.

This is also the case for input tax relating to purchases that are not wholly used for furtherance of taxable business activity, for example, when they are used for the private needs of the business owner or its employees (i.e. final consumption).

Most OECD countries also have legislation in place that provides for input tax deduction blocking on a number of goods and services because of their nature rather than because of their use by businesses, generally with a view to ensure (input) taxation of their deemed final consumption e.g. restaurant meals, reception costs, hotel accommodation, use of cars by the employees of businesses, etc.

Chapter 4 – Measuring performance of VAT: The VAT revenue ratio

Given the diversity in the implementation of VAT between countries, it is reasonable to consider the influence of these features on the revenue performance of VAT systems.

One tool considered as an appropriate indicator of such a performance is the VAT Revenue Ratio (VRR), which is defined as the ratio between the actual VAT revenue collected and the revenue that would theoretically be raised if VAT was applied at the standard rate to all final consumption (Table 4.1).

In theory, the closer the VAT system of a country is to a “pure” VAT regime (i.e. where all consumption is taxed at a uniform rate), the more its VRR is close to 1.

On the other hand a low VRR can indicate a reduction of the tax base due to a large number of exemptions or reduced rates or a failure to collect all tax due (e.g. tax fraud).

The main methodological difficulty for calculating the VRR lies in the assessment of the potential tax base, since no standard assessment of the potential VAT base for all OECD countries is available.

In the absence of such data, the closest statistic for that base is final consumption expenditure as measured in the national accounts.

Few countries have a high VRR and most have a ratio below 0.65, which confirms the impact of the wide range of exemptions and reduced rates applied in OECD countries.

However, VRR figures should be interpreted with caution since they result from a combination of the policy efficiency (capacity to tax the full base at the standard rate) and compliance efficiency (the capacity of the tax administration to collect the tax due).

In addition, a number of factors such as the evolution of consumption patterns, incomplete application of the destination principle and the tax treatment of government activities may have a significant influence on the VRR in some countries.

Whilst the VRR is a useful tool for observing countries’ performance, more work is needed to identify the specific factors that influence the performance of VAT and how they interact.

Chapter 5 – Selected excise duties in OECD member countries

Excise duty, unlike VAT and general consumption taxes, is levied only on specifically defined goods. The three principal product groups that remain liable to excise duties in all OECD countries are alcoholic beverages, mineral oils and tobacco products.

While excise duties raise substantial revenue for governments, they are also used to influence customer behaviour with a view to reducing polluting emissions or consumption of products harmful for health such as tobacco and alcohol.

While the main characteristics and objectives ascribed to excise duties are approximately the same across OECD countries, their implementation, especially in respect to tax rates, sometimes gives rise to significant differences between countries (Tables 5.1 to 5.5).

For example, excise duties on wine (Table 5.2) may vary from zero to more than USD 2.5 a litre. Current excise rates for mineral oil products again illustrate the wide disparity.

For example, excise taxes on premium unleaded gasoline vary from USD 0.109 in the United States to USD 1.483 in Turkey for 1 litre.

A much more significant feature of excise duties on mineral oils is the fact that duty rates have been used to affect consumer behaviour to a greater degree than in other areas. Tobacco products are subject to excise taxes that most often rely on a combination of ad valorem and specific elements.

Chapter 6 – Taxing vehicles

Motoring has been an important source of tax revenue for a long time thanks to a wide range of taxes imposed on users of public roads.

Vehicle taxation in its widest definition represents a prime example of the use of the whole spectrum of consumption taxes.

These taxes include taxes on sale and registration of vehicles (Tables 6.1 and 6.3); periodic taxes payable in connection with the ownership or use of the vehicles (Table 6.2); taxes on fuel (Table 5.4) and other taxes and charges, such as insurance taxes, road tolls etc.

Increasingly, these taxes are adjusted to influence consumer behaviour in favour of the environment.

Table 5.3 illustrates, as an example, the wide differences in the level of taxes on sale and registration of motor vehicles. Indeed, the maximum tax for passenger cars may vary from less than 7% of the value of the car in Washington, DC, to 195% in Copenhagen.

Environment issues are increasingly taken into consideration for the design of vehicle taxation since it is increasingly considered as an efficient tool to influence customer behaviour and encourage the purchase of low polluting vehicles.

In 2012, more than two thirds of OECD countries apply rate differentiation according to environmental criteria.

Indirect Tax Strategic Plan

In response to increased scrutiny from Boards, Revenue Authorities and other regulators, many businesses are now formally documenting their indirect tax strategy and implementing formal processes to evaluate and approve planning ideas.

For leading companies, a tax strategy is a dynamic framework that is shaped by internal and external drivers.

A tax strategy should cover all key taxes and business locations and should be aligned to the overall business strategy.

Potential Benefits Of A Documented Indirect Tax Strategy Include:

Obtaining clarity around the business’ indirect tax risk appetite, which should facilitate the identification of planning opportunities appropriate to the business’ wider commercial objectives

Providing the business with a consistent and efficient review and evaluation process over tax-related matters

Raising the profile of Indirect Tax with key business and Finance stakeholders

Monitoring and strengthening governance procedures in decentralized and overseas jurisdictions

Tax Control Framework

Tax Control Framework forms an integral part of an organisation’s Business or Internal Control Framework, ensuring that the organisation’s processes have been structured so that the tax risks or potential savings become visible on time.

Proving The Reliability Of Accounting Records For Tax Purposes

The New Trend might be to have a more open dialogue between revenue bodies, taxpayers, and tax intermediaries. The at times prolonged operational audits performed by the tax authorities seem to be turning into a thing of the past.

Initiatives Of Tax Authorities

In 2005, the Netherlands Tax and Customs Administration (TCA) initiated a pilot ‘horizontal monitoring’ programme involving 20 of the country’s largest corporate taxpayers

In 2005, the United States initiated a Compliance Assurance Process

In September 2005, the Irish Revenue Commissioners initiated their ‘Co- operative Compliance’ programme with large corporate taxpayers.

With the arrival of horizontal supervision the Netherlands, combined with the use of audit samples and data analyses, businesses can prove the reliability of their accounting records for tax purposes themselves, which offers the opportunity to avoid supplementary tax assessments and penalties.

The following benefits may be realised if VAT pre-audits are performed using, among other things, data analyses and audit-sample techniques:

Improved relations with the Tax Inspector (evidently, by using audit techniques similar to those used by the Tax Office, the first hurdle in any future discussions about the outcome of an audit is already taken).

Businesses obtain an understanding of the nature and scope of their tax risks in a statistically reliable, quick and efficient way.

The quality of the assessment of procedures performed by external auditors will increase, because they will have to spend less time on assessing risks in the tax chapter in the fields of, for instance, indirect taxes, payroll tax and national insurance contributions.

Less “vertical” audits and lower costs to be incurred on using business resources for such audits

Lower penalties

Statistical Sampling

Statistical Sampling is the tax audit methodology of the Dutch Tax Authorities and it can be used by companies for proactive audit defense: pre-audit and detective control resulting in quantification of potential amount of exposures and/or savings.

By identifying risks respectively opportunities, an action plan pertaining to both the future and the past may be drawn up to mitigate these risks or realize savings.

Data Analytics

An alternative for performing an efficient tax audit would be data analysis. Data-analysis options have increased and been refined rapidly over the past few years, allowing for large data volumes to be reviewed in an effective and efficiently way. Besides, data analyses can usually be performed using the same software tool as that used to statistical sampling.

The tone at the top that a tax savvy board directs to properly address tax risk will maximize stakeholder value in many ways and it critical to sustaining compliant, yet minimized tax expenditures. Does tax have a seat in your boardroom?

Comments For The Record United States Senate Committee On Finance

The Center for Fiscal Equity proposes a large ball solution with four major provisions:

A Value Added Tax (VAT) to fund domestic military spending and domestic discretionary spending with a rate between 10% and 13%, which makes sure very American pays something.

Personal income surtaxes on joint and widowed filers with net annual incomes of $100,000 and single filers earning $50,000 per year to fund net interest payments, debt retirement and overseas and strategic military spending and other international spending, with graduated rates between 5% and 25% in either 5% or 10% increments. Heirs would also pay taxes on distributions from estates, but not the assets themselves, with distributions from sales to a qualified ESOP continuing to be exempt.

Employee contributions to Old Age and Survivors Insurance (OASI) with a lower income cap, which allows for lower payment levels to wealthier retirees without making bend points more progressive.

A VAT-like Net Business Receipts Tax (NBRT), which is essentially a subtraction VAT with additional tax expenditures for family support, health care and the private delivery of governmental services, to fund entitlement spending and replace income tax filing for most people (including people who file without paying), the corporate income tax, business tax filing through individual income taxes and the employer contribution to OASI, all payroll taxes for hospital insurance, disability insurance, unemployment insurance and survivors under age 60.

We have no proposals regarding environmental taxes, customs duties, excise taxes and other offsetting expenses, although increasing these taxes would result in a lower VAT.

American competitiveness is enhanced by enacting a VAT, as exporters can shed some of the burden of taxation that is now carried as a hidden export tax in the cost of their products. The NBRT will also be zero rated at the border to the extent that it is not offset by deductions and credits for health care, family support and the private delivery of governmental services.

Some oppose VATs because they see it as a money machine, however this depends on whether they are visible or not. A receipt visible VAT is as susceptible to public pressure to reduce spending as the FairTax is designed to be, however unlike the FairTax, it is harder to game. Avoiding lawful taxes by gaming the system should not be considered a conservative principle, unless conservatism is in defense of entrenched corporate interests who have the money to game the tax code.

Our VAT rate estimates are designed to fully fund non-entitlement domestic spending not otherwise offset with dedicated revenues. This makes the burden of funding government very explicit to all taxpayers. Nothing else will reduce the demand for such spending, save perceived demands from bondholders to do so – a demand that does not seem evident given their continued purchase of U.S. Treasury Notes.

Value Added Taxes can be seen as regressive because wealthier people consume less, however when used in concert with a high-income personal income tax and with some form of tax benefit to families, as we suggest as part of the NBRT, this is not the case.

With governments increasingly coming to rely on revenue from indirect taxation, managing value-added and sales tax exposure has rapidly become one of the most important tax issues facing companies doing business in several jurisdictions, alongside transfer pricing.

Many studies have shown that indirect tax rates have been on rise since before the financial crisis indicating a general shift away from direct taxation on income and towards the taxation of consumption. However, there is no doubt that the pace of consumption tax rate increases has accelerated in the past three or four years with government finances increasingly under strain.

This trend has been particularly notable in Europe, where the following countries have lifted value-added tax standard rates in the past year:

United Kingdom – from 17.5% to 20%

Ireland – from 21% to 23%

Cyprus – from 15% to 17%

France – from 19.6% to 21.2% (from October 2012)

Italy – from 21% to 23%

Hungary – from 25% to 27%

Spain – from 16% to 18%

Portugal – from 20% to 23%

Greece – from 19% to 23%

This has taken the average VAT rate in the EU to over 21% this year, from around 19.5% just before the crisis. However, this trend is by no means restricted to just Europe. The Thomson Reuters ONESOURCE Indirect Tax report for the third quarter of 2011 shows that, outside of the United States, there were 14 sales tax increases and four news taxes around the world in those three month alone. And in the same period, there were 97 indirect tax increases and 96 new indirect taxes at state and local level in US.

Obviously, such changes are also being felt by individuals as well as businesses. The Tax Foundation (TF) has pointed out that sales taxes in the United States, which are levied not only by state governments but also by city, county, Native American and special district governments, can have a profound impact on the total rate that consumers see at the check-out register.

Governments are also using less visible means to extract more revenue from consumption tax systems, including by increasing concessionary rates of tax which are usually charged on ‘essential’ or educational goods and services such as children’s clothing, books and newspapers. In the UK for example, there has been much controversy over the government’s decision in the 2012 Budget to remove a number of anomalies and inconsistencies from VAT legislation by placing a number of goods, mainly certain foodstuffs, that were previously zero-rated on the list of items attracting VAT at the standard rate (a move since dubbed as Chancellor George Osborne’s ‘pasty tax’). France, Greece, Italy, Norway, Poland, Portugal and the Czech Republic have also raised their reduced rates recently.

This complexity has led many countries to crackdown on VAT and GST fraud in an effort to discourage traders from taking advantage of unintended loopholes in indirect tax legislation or to commit more serious acts of fraud, especially those conducted in more than one state. Again, this has been an increasingly visible trend in Europe, and has led to greater levels of cooperation and information-sharing on taxpayers between national revenue authorities. For example, in January this year, it was announced that a Franco-Austrian partnership agreement designed to strengthen the exchange of information to uncover VAT fraud has proven to be highly effective in practice. Also, much is being done at EU level by the European Commission to eradicate VAT fraud; in November 2010, EUROFISC was established to provide a network of national tax officials with the aim of detecting and preventing fraud before it occurs.

With indirect taxes like VAT now so important to state budgets (a 1% change in the VAT rate in the UK, for example, is worth about GBP6bn per year in revenue), it is a sure thing that governments are going to continue honing their VAT/GST regimes to extract more revenues from taxpayers. Indeed, Ernst and Young’s 2011-12 Tax Risk Survey showed that 69% of tax policy makers expect to generate more revenue from indirect taxes in the future, and such taxes are expected to be the leading source of new revenue over the next decade.

With the world’s economic troubles far from over, and the sort of revenue-producing levels of growth not expected for some time, businesses, therefore, are likely to face on-going change in the area of indirect taxation in many part of the world.

Aim Of The Blog

This Blog is not about whether effective tax planning is right or wrong, but raises the question whether besides evaluating tax risks (level of tolerance) also reputational risks of the company as part of tax risk management should be determined and managed accordingly.

I don’t necessary agree with the content of various public statements below. For management purposes the objective is to predict the mindset of the public opinion.

Is the public opinion important for tax planning and the company’s business objectives?

Has that changed due to economic climate?

What drives public opinion?

What is the impact on the reputation of the tax professional if planning is implemented and becomes unforeseen public knowledge?

How important is the reputation of the tax professional to establish company’s tax objectives such as tax controversy (‘enhanced relationships’ with tax authorities).

I quoted recent news stories that might influence public opinion overall. What would the opinion be if this is read by someone not in the tax profession?

Tax specialists.. Are You Conscious Of Your Reputation?

How about the perception of integrity of the tax profession?

Some quotes of a blog I recently read.

“The Chief Political Commentator of the Telegraph, Peter Osborne, recently wrote one of the most damning verdicts. He stated ‘there are few more worthless specimens of humanity than tax accountants and tax lawyers’.”

“Mark Robertson, representing the investment research service Eiris, highlighted how ‘significant reputational damage in the form of negative publicity arising from aggressive tax evasion’ can create financial risks for organizations.”

“Joe Stead from Christian Aid noted that ‘becoming known as a tax dodger can damage a company’s reputation and lead to costly penalties’.

The Changing World From An Adviser Perspective

A tax professional should contribute and give guidance to achieve that taxpayers do not pay more tax than necessary. Every opportunity has to be considered and because of the different and highly competitive market in the past aggressive indirect tax planning structures were proposes and implemented.

In the indirect tax field, especially value added tax, this kind of aggressive structures were for a long time often approved by case law. That has changed when the European Court of Justice ruled a couple of years ago that such behavior had to be punished and the tax advantage was revoked or denied.

The tax profession had to change as well and reposition itself to ‘manage the numbers of indirect tax’ (focus more on risk management) and because of new trends relationships with tax authorities became (more) important to realize the associated taxpayer’s tax objectives.

A New trend: Open Dialogue Between Revenue Bodies, Taxpayers And Tax Intermediaries

In 2005, the Netherlands Tax and Customs Administration (TCA) initiated a pilot ‘horizontal monitoring’ programme involving 20 of the country’s largest corporate taxpayers. At the core of the programme is a concerted effort by the TCA to build greater trust with this taxpayer constituency as a means of encouraging greater disclosure of tax uncertainties and risks.

Even if the authorities have not embraced such an approach (yet), a proactive mode can not only safe time and money but result in a good relationship.

Is What Apple Did Wrong?

“Apple’s headquarters are in Cupertino, Calif. By putting an office in Reno, just 200 miles away, to collect and invest the company’s profits, Apple sidesteps state income taxes on some of those gains. California’s corporate tax rate is 8.84 percent. Nevada’s? Zero. Setting up an office in Reno is just one of many legal methods Apple uses to reduce its worldwide tax bill by billions of dollars each year.

As it has in Nevada, Apple has created subsidiaries in low-tax places like Ireland, the Netherlands, Luxembourg and the British Virgin Islands — some little more than a letterbox or an anonymous office — that help cut the taxes it pays around the world.

Almost every major corporation tries to minimize its taxes, of course. For Apple, the savings are especially alluring because the company’s profits are so high. Wall Street analysts predict Apple could earn up to $45.6 billion in its current fiscal year — which would be a record for any American business. Without such tactics, Apple’s federal tax bill in the United States most likely would have been $2.4 billion higher last year, according to a recent study by a former Treasury Department economist, Martin A. Sullivan.”

“As resident of Europe if you buy services from Apple via the iTunes store no local VAT is due unless you are a resident of Luxembourg. The supply is subject to Luxembourg VAT. No surprise that Apple and Microsoft and many others run both their European operations from Luxembourg.”

In Hungary the standard VAT rate is 27%. The standard VAT rate in Luxembourg is still 15%. That means at least a VAT saving of 12% per transaction.

About Change And Competencies

The contribution of a tax professional is nowadays not only on not paying more tax than necessary and evaluating associated tax risks when implementing (rate level of tolerance on a risk scale), but should also take in consideration the impact of such planning on the reputation of the company.

What is the impact if the tax planning becomes public knowledge? What are the consequences if a newspaper or politician picks it up to make statements about lack of ‘tax morale’ and the company is used as case study?

“On his 2008 Presidential campaign trail, Barack Obama made his hostility toward “offshore” jurisdictions very clear: “There’s a building in the Cayman Islands that houses supposedly 12,000 U.S.-based corporations. That’s either the biggest building in the world or the biggest tax scam in the world, and we know which one it is.”

“Is China displacing U.S. jobs?” asks Scott Paul, executive director at the Alliance for American Manufacturers, a trade lobby. “No question about it. A lot the job losses have come from innovative states like Massachusetts, North Carolina, Texas and California, where they do all the innovating, but China does all the manufacturing for them. The problem with that model is that manufacturing and production is where the middle class jobs are. China has had a huge impact on the U.S. economy,” Paul says.

“International tax evasion by multinational companies that take advantage of tax-rate disparities among countries is on the rise, according to an international study group. By claiming multiple deductions and generating fake credits, corporations can cancel out taxes owed, said the Paris-based Organization for Economic Cooperation and Development on Monday. In a 25-page report, the OECD said billions of dollars of tax revenues were at risk through aggressive tax planning techniques used by companies to exploit tax rate differentials. The report says companies exploit national differences in the tax treatment of instruments, entities or transfers to deduct the same expense in several different countries, to make income ‘disappear’ between countries or to artificially generate several tax credits for the same foreign tax.”

The management of reputational risk is in my view a corner stone of tax controversy and becoming even more important in times of tax authority scrutiny as method of governments to balance their budgets.

The reputation of a company and that of a tax professional either in-house or external are linked. The reputation of a tax professional, both current and past, is a key driver to contribute real value to the taxpayer’s tax controversy objectives nowadays and in the future.

What Determines Our Reputation?

A Tax Controversy objective ‘achieving mutual trust via ‘an ‘enhanced relationship’ is difficult to meet if the tax professional in-house or as representative of the taxpayer has a reputation of planning and implementing ‘tax’ schemes that allocates taxation to low rate countries abroad. Trust has to be earned and (mis)perceptions about ethical standards could cause real bottlenecks.

Is that also the real market danger for Apple: the mindset of the public opinion? What is the impact on Apple’s reputation with respect to this kind of stories?

Apple customers and suppliers face increase of taxes and you hear that Apple does not pay taxes (highly profitable). Would that customer have an opinion about tax morale in general and benchmark that with Apple’s tax strategy?

A public opinion is also about the perception of Apple ethics beyond tax via dotting all the pieces of bad press lately such as labor conditions and outsourcing manufacturing to China (losing US jobs).

What is the public opinion about the company’s code of conduct?

Has that opinion changed and what was the cause effect?

Does that impact Apple’s future tax strategy?

If you focus only on evaluating tax risk (level of tolerance) probably not. However, is such an analysis enough from a tax strategy perspective nowadays?

In Apple’s defense lots of multinationals are doing the same and change of the tax system – as those structures are often legally allowed – is the only way to close such gaps. I refer to Obama’s quote:

“There’s a building in the Cayman Islands that houses supposedly 12,000 U.S.-based corporations.”

Management By Apple

Based on the statement below it is likely that this risk has been foreseen, considered manageable and thus likely no need necessary to change its tax strategy at least for now. Apple’s message below highlights what has been contributed. The method is counterattack by telling – supported by facts – why such statements or public perception as mentioned above (all the questions raised) should be considered wrong.

Apple stresses publicly its code of conduct: ‘doing the right thing’ and ‘highest ethical standards complying with applicable laws and acounting rules’. Apple responded also very quickly.

It shows now a process from start (worse case scenario) to finish (game plan) as it includes also how Apple manages reputational risk.

Apple’s statement:

Over the past several years, we have created an incredible number of jobs in the United States. The vast majority of our global work force remains in the U.S., with more than 47,000 full-time employees in all 50 states. By focusing on innovation, we’ve created entirely new products and industries, and more than 500,000 jobs for U.S. workers — from the people who create components for our products to the people who deliver them to our customers. Apple’s international growth is creating jobs domestically since we oversee most of our operations from California. We manufacture parts in the U.S. and export them around the world, and U.S. developers create apps that we sell in over 100 countries. As a result, Apple has been among the top creators of American jobs in the past few years.

Apple also pays an enormous amount of taxes which help our local, state and federal governments. In the first half of fiscal year 2012 our U.S. operations have generated almost $5 billion in federal and state income taxes, including income taxes withheld on employee stock gains, making us among the top payers of U.S. income tax.

We have contributed to many charitable causes but have never sought publicity for doing so. Our focus has been on doing the right thing, not getting credit for it. In 2011, we dramatically expanded the number of deserving organizations we support by initiating a matching gift program for our employees.

Apple has conducted all of its business with the highest of ethical standards, complying with applicable laws and accounting rules. We are incredibly proud of all of Apple’s contributions.

Apple’s Public Image Is Made Of Teflon

“When the New York Times claimed incorrectly last year that General Electric (GE) paid zero federal taxes in 2010 on worldwide profits of $14.2 billion, the company’s reputation took a steep and prolonged hit, as measured by YouGov’s BrandIndex Reputation score.
Not so Apple (AAPL).

When the same paper ran a front-page story last week detailing — again incorrectly, according to Forbes — the lengths to which Apple has gone to avoid paying taxes, the company’s consumer reputation barely budged.

In fact, based on responses to the question “Would you be proud or embarrassed to work for this brand?” Apple’s reputation score actually went up modestly a few days after the Times story broke, according to a YouGov report issued Tuesday.

The market research firm concluded that Apple’s public reputation is “virtually Teflon” — at least in terms of tax avoidance.”

Richard Cornelisse is CEO of the KEY Group and worked previously as Big4 Partner in the Tax Performance Advisory and Indirect Tax Practice and blogs on Tax Function Effectiveness and Tax Control Framework developments.

First Kelvin and I like to thank Chris Walsh and John Walsh for their opinion (see Blog March 1 the comment box). I agree with John that the government has to make choices and if you know the macroeconomics effects that you could manage the regressive nature of VAT (Chris comment).

I agree also with the executive summary that an increase of prices can have a major impact on the economy especially in the downturn.

Contra Arguments Re Executive Summary

If I look at the executive summary one of the troubling aspects is the reduction of employment of 850,000. That might be true but does the introduction of VAT not create a lot of jobs as well? That could be substantial in my view. Companies need to manage their VAT Throughput to mitigate risk and realize opportunities, change means training of people, technology firms need to develop new systems/software etc, tax authorities need to check much more supplies and of course advisers and management consultants need to offer a helping hand. What is the positive impact on employment? How do you see this?

Chris Walsh shared his opinion re executive summary in the comment box of Blog of March 1.

My Opinion

Introducing a VAT system is the right way to combat the deficit, but I have doubts about the timing and whether this is a realistic scenario. In the end it is all about politics.

Timing

Based on the macroeconomic data is it smart to introduce a VAT system in the downturn. Is the first priority not to realize economic growth, establish trust in the market and therefore should the focus not be on findings ways to increase consumer spending. Is the introduction of a VAT system not counterproductive?

That is also why Kelvin and I have linked the US introduction question to the trend of increase of VAT rates in countries that have a VAT system. Does that make sense? It does not stimulate economic growth.

Realistic Scenario

In my Blog ‘Is Google The Adviser Of The Future’ I wrote: when somebody wins, somebody else must lose. Without any doubt indirect tax is the right and maybe only way to combat the deficit. Why? I don’t see the US government cut their spending, definitely not in the downturn. However, who might feel a loss and what do politicians need to manage to make it happen?

Besides the end consumer companies might consider it a huge loss. The implementation and compliance costs (e.g. managing ongoing the VAT numbers) are bottom line costs of companies and a decrease of corporate income tax is above the line. The impact of the shift from direct (lowering corporate income tax) to indirect tax might not be seen as a positive.

The US is known for their powerful lobby groups. I believe that too many might feel a loss to make it politically feasible. If we look again at the report by National Retail Organization we know that the retail industry in general will face these costs and it is not a real surprise that the negatives are highlighted. It is their report and maybe those highlights were part of the scope of work of its advisers. The results contribute to their own strategic aim and their lobby against has already started.

As said we like to facilitate a discussion and as we are not (like Chris Walsh) US experts we truly appreciate his and your opinion.

By the way I found a website that links all articles, video etc that explain and advocate a Value Added Tax For the United States. I have updated our Blog of March 1 also with this link.

Richard Cornelisse is CEO of the KEY Group and worked previously as Big4 Partner in the Tax Performance Advisory and Indirect Tax Practice and blogs on Tax Function Effectiveness and Tax Control Framework developments.

Tax Management Consultancy welcomes your opinion on any of the issues raised, so feel free to join in the discussion on LinkedIn | Twitter | Facebook.

M&A Integration and Indirect Tax: Managing the Moving Parts Before, During, and After a Transaction

BY RICHARD CORNELISSE

With indirect taxes intertwining through the day- to-day operations of a company—raising sales invoices, moving inventory, paying suppliers, collecting cash—indirect tax risk can have a distinct and domino-like effect on the commerciality of an organization.

The impact can increase exponentially in the event of a merger or acquisition. But do these taxes and tax planning opportunities get the attention they need, especially in light of increasingly complicated and globalized business models?

In a simpler time, due diligence for the purchaser typically focused on identifying, assessing, and quantifying historical indirect risks. The aim was to provide insight into these risks and build into the contract adequate coverage in case (risk) history repeated itself. Armed with this information, the buyer could negotiate a reduction of the selling price or secure indemnification from the identified risk.

The tax advisory input also would extend to opportunities inherent in the deal structure. With effective planning, deal costs would cascade down the group to sit in an appropriate entity for commercial and corporate income tax deduction purposes, and value-added tax would not ‘‘stick’’ as an unrecoverable cost—at a rate of up to 25 percent in the European Union (Hungary even 27%).

Asset deals are less rigorously subject to tax due diligence: The historical risk usually remains with the seller and the buyer takes on only the risks directly associated with the assets. In cases where all the assets qualify as a business going concern, the transfer might not be subject to VAT. The seller would not have to charge and report VAT, the buyer would not have to pay or deduct VAT, and both parties could see a cash flow advantage.

Transactions in Today’s Business World

Even as the world is shrinking, businesses and their growth strategies are becoming more complicated. A schematic drawing of the functions of a typical multinational today might look like a Rube Goldberg contraption—a complex of moving parts that must connect one to another for tax, regulatory, and reporting purposes.

And unlike the more contained structure for handling income-based taxes, responsibilities and key drivers for indirect taxes may be spread throughout the enterprise, residing not just in the tax department but in any of such diverse departments as finance, information technology, supply chain management and logistics, human resources, and beyond.

Added is the growing trend toward shared service centers (SSCs) that are responsible for operational processes including accounts payable and accounts receivable as well as other outsourced functions for tax, finance, and treasury. Tax determination and reporting for the entire operation may be governed by one or more enterprise resource planning systems, which in turn may be integrated to varying degrees, with or without the benefit of sophisticated technology tools.

All these factors make for a changing and increasingly sophisticated business environment that requires a different approach to business indirect tax advice. Although fundamental tax due diligence is still a requirement for the purchase of a company or assets, it is only the opening chapter. Equally important are exploring and thinking through options for structuring the indirect tax profile and how it will function in the organization post acquisition and throughout implementation and integration.

A Look at Some Critical Questions

Asking the critical questions—whether of outside advisers or company leadership—can help focus on the relevant issues in these areas of particular importance.

Processes and Controls, History and Knowledge

What are the new processes and controls going to be?

Who owns these controls?

Will the tax knowledge of the acquired business be retained or will there be key staff resignations?

What technology will be retained?

Who is aware of the tax planning history and can help make sure that the proper structures are maintained?

How will the seller’s processes and systems be integrated?

The New Structure and VAT

Should VAT be charged on the sale? If so, what country’s VAT should be applied and at what rate?

Who is liable for any VAT chargeable, and if chargeable can this be deducted?

Who is responsible for VAT errors and penalties?

How will inventory be integrated into the new purchaser’s supply chain?

Will using a classic principal structure in the new entity help keep maximum profits in low-tax jurisdictions? If so, one entity will own title to inventory throughout the various jurisdictions and the principal would require a VAT registration in each location where inventory is held.

Where will the regional inventory hubs be located? Careful planning of the hub locations will allow VAT on import to be deferred to a point where it no longer represents a cash flow cost to the business. Conversely, poorly implemented ‘‘virtual’’ VAT inventory systems can have the opposite effect: With each national entity able to move its own goods to a foreign jurisdiction, ostensibly to maintain a minimal level throughout the region, the actual result could be that every national subsidiary would require a VAT registration in every other European jurisdiction.

Are U.S. foreign tax credits to be used with transactions occurring outside the United States? A VAT registration is generally needed where inventory is held. In some countries, particularly those in Asia and Latin America, a VAT registration will crystallize a permanent establishment for corporate income tax purposes. This would mean a massive increase in the U.S. corporation’s foreign tax compliance obligation and could substantially increase the amount of tax due as well as the workload.

Where will the deal costs sit? Deal costs are generally cascaded so that the corporate income tax deduction can be taken at the appropriate entity. But when the cost remains in a holding company, VAT will be an absolute cost to the transaction.

What Happens to VAT When the Business Model Changes?

A change in the business model can actually create VAT risks. For example, the selling arrangement may change from a buy/sell to broker/agent or vice versa. Goods purchasing may become centralized. The flows and storage locations of goods may change.

In any of these cases, new VAT registration obligations may be created in different countries.

Likewise, VAT could be chargeable by different entities and the recoverability of the VAT could change, and different billing flows are created.

Accounts Payable/Accounts Receivable

As the acquisition integration continues, something as basic as a billing error leading to invoices issued in the wrong name could not only delay revenue receipt but also result in nonrecoverable VAT. The penalties for incorrect invoicing can be a percentage of the turnover, so amounts can quickly become material—up to 25 percent VAT in Europe (Hungary 27%) on the turnover plus penalties.

Intangible Assets

One of the fundamental questions to answer is where the ownership of intangible assets will sit in the new structure and whether it will be migrated to a low-tax jurisdiction. We have seen VAT charged on the sale of intangible assets from one U.S. corporation to another because the assets were exploited in Europe and the acquiring company had not planned ahead to assure proper registrations were in place.

In one case, VAT was not recoverable and the company incurred an unexpected cost to the transaction of about 20 percent of the value of the intangible asset. This is a prime example of relying on due diligence from a historical perspective. If intangibles were not an issue before, the historical risk would not show up but the current and future risk would loom large.

Look in the ‘I’s

As anyone who has lived through the M&A experience knows, there are a number of moving parts rela- tive to indirect tax. It is not uncommon for some things to be overlooked or underplanned. But when that happens, serious and material consequences can occur, substantially affecting the cost as well as the ultimate success of the transaction.

Implementation

Once a commercial and tax-efficient structure is determined—one that addresses both historical and potential risk—it is time to take the theory behind the structure into the realm of practice.

Who is taking care of filing VAT registrations? When should you apply for VAT registration, since average lead times in jurisdictions can be several months? Who is responsible for maintaining a structure and making sure the business is acting in accordance with the model? How is this communicated throughout the organization? How will ongoing monitoring be handled?

Most ERP systems, including SAP, Oracle, JD Edwards, and Peoplesoft, are equipped with some form or forms of VAT functionality. However, they typically still require significant configuration and may need to be customized to deal properly with indirect taxes. They will also need to be updated and tested to reflect new contracts and billing flows. Ownership of these tasks must be determined and communicated up front, so that the ERP system can accurately issue invoices from day one.

Integration

The next stage involves integrating the legacy business into the new business if possible, or devising a hybrid model through which the two legacy systems run side by side. Although a fully integrated system is more likely to yield greater economies of scale, tax knowledge continuity is critical to managing risks in either case.

The continuity includes others outside the tax arena—the logistics team who understands the physical shipments and flow of goods and would complete and submit customs declarations; the shared service center clerks who actually create the sales invoices; the IT team who manages data sharing between different systems.

Impact

The impact we are talking about here is largely concerned with potential problems and cautionary tales. What if VAT registration is not obtained on time? The ERP system is not tested or updated? There is no central ownership of key processes? Appropriate project team participants do not understand the material impact of indirect tax?

The results of these gaps in practical application can range from logistical problems (customs not allowing goods to clear in a country) to invoicing errors (invoices needing to be redone and cash collections delayed), from incorrect tax treatment on transactions to difficulties in VAT compliance that can result in payment and reporting errors and penalties.

Interim Solutions and Workarounds

When the new business model cannot be implemented into the purchaser’s own ERP system within a given time frame, the typical solution is to temporarily outsource the process to the seller through a temporary service agreement. But such workarounds, however practical, can lead to new risks.

In an asset deal, for example, an ongoing relationship with the seller as part of the transition agreement could be seen as outsourcing VAT accounts payable/accounts receivable processes. That in turn could trigger VAT compliance issues, difficulties in accessing data, questions around the quality of VAT controls, and blind reliance on an ERP set up with an outcome that could not be verified.

There are possible people issues as well. Although the vendor’s (seller’s) staff and systems are used to bridge the gap until the necessary resources, knowledge, systems, registrations, and authorizations are in place, the people doing the work have no real vested interest in the new model. In fact, they may even be losing their jobs because of the merger or acquisition.

Invoicing in the Interim

In worst case scenarios, staff members may not feel responsible for the work they are doing. We have seen results that, if not costly and catastrophic, certainly undermine the functionality and credibility of the enterprise.

One of the most common side effects of an integration that cannot be fully realized surfaces in the realm of invoicing. For example, large numbers of payable invoices are not correctly coded so VAT is not deductible. Or when the legacy system is only half integrated into the new model, incorrect sales invoices are issued, causing problems for customers, incorrect reporting of tax figures, and missed compliance obligations.

Knowing who is legally obliged and practically able to issue invoices is critical in interim or transitional situations. Is the previous owner legally allowed to issue invoices? Whose VAT compliance issues are these and how can the new owner obtain and share information? Can the new company continue billing its customers? Implementing a transitional arrangement—especially if it is unplanned—can be expensive, causing delays to the overall integration and setting practical, commercial risks into motion.

An Indirect Tax and Acquisition Checklist

Indirect tax risks are prevalent throughout the entire M&A and integration process. Here are some of the leading practices, lessons learned, and perspectives to keep in mind so that they do not become stumbling blocks:

Set up a project charter that will take effect as of the very first due diligence activities.

Validate due diligence findings and define priorities.

Make an indirect tax integration plan and ensure that the right sponsors provide buy-in.

Map out the current state upon acquisition and identify key risk areas, opportunities, and people in the organization acquired.

Jointly validate and refine the integration plan and develop a road map to success.

A relevant indirect tax strategy—correctly implemented—will allow the new business to function effectively from go-live, from both a tax and commercial perspective, so that it can move inventory, generate sales and invoices, face fewer disputes with non-paying customers, remain tax compliant, and integrate the business on time and on budget.

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The Governments of the Gulf Cooperation Council (GCC) – Bahrain, Kuwait, Oman, Qatar (status unknown due to GCC politics/friction), Saudi Arabia and the United Arab Emirates that make up GCC – are committed to form a common framework for the introduction of value added tax (VAT) in the region. In order to achieve conformity within … Continue reading Being re […]

A partnership is closed between the Key Group, SNI and the international operating SAP consultancy firm ‘ConVista Consulting’ with offices amongst others in Madrid and Barcelona. Key Group and SNI operate from Netherlands, Poland and Turkey. Who we are In order to establish synergies to support business SAP challenges of our clients we have setup … Continue […]

The term materiality has many meanings and definitions. Boundaries of materiality are primarily determined based on personal estimations. This can be estimations by auditors, risk management departments, company directors, etc. The term materiality, used as a quantitative norm, then serves as an approval boundary. Evidently, the materiality used to determine […]

We offer a new SAP add-on solution that creates automatically the VAT Smartform from SAP. When our SAF-T SAP add-on solution has been purchased this additional functionality will be managed under SAF-T cockpit as a different report. Companies selling across European Union borders have to submit EC Sales List (ESL). This should contain the details … Continue […]

In Spain a new VAT reporting system will enter into force on the 1st of July 2017. The new Spanish requirements will have a huge impact on many (multi)nationals that run SAP as standard SAP will not provide an E2E solution. SAP add on for SII The SAP add-on is based on the selection of … Continue reading In Spain on 1 July 2017: immediate supply of Informati […]

SII (“Suministro Inmediato de Información”) in Spain is about changing the current VAT management system which has been in place for 30 years, introducing a new bookkeeping system for VAT on the AEAT online system, by providing all billing records virtually immediately. The new Immediate Supply of Information accelerates the gap between recording or booking […]

Tax authorities around the world want to receive more frequent and faster tax relevant data for e-audit purposes to analyse Corporate Income Tax (CIT) and VAT positions taken to combat VAT fraud and to determine whether actually a fair share is paid (Base Erosion and Profit Shifting: ‘OECD’s BEPS’). More countries will therefore move to … Continue reading A […]

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Tax Management Consultancy is designed to keep readers abreast of current developments, but it is a general guide only and is not intended to be a comprehensive statement of the law. No liability is accepted for the opinions it contains, or for any errors or omissions